Topic: Working Capital Management

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FM – May 2019 – L3 – Q7 – Working Capital Management

Evaluate the financial viability of accepting a new customer order and provide considerations for granting credit.

Question

V Plc. manufactures engineering equipment. The company has received an order from a new customer for five machines at N5,000,000 each. V Plc.’s terms of sale are 10 percent of the sales value payable with the order. The deposit has been received from the new customer. The balance is payable 12 months after acceptance of the order by V Plc.

V Plc.’s past experience has been that only 60 percent of similar customers pay within 12 months. Customers who do not pay within 12 months are referred to a debt collection agency to pursue the debt. The agency has in the past had a 50 percent success rate of obtaining immediate payment once they became involved. When they are unsuccessful, the debt is written off by V Plc. The agency’s fee is N500,000 per order, payable by V Plc. with the request for service. This fee is not refundable if the debt is not recovered.

As an accountant in V Plc.’s credit control department, and based on the company’s past experience and on discussions with the sales and credit managers, you do not expect the pattern of payment and collection to change.

Incremental costs associated with the new customer’s order are expected to be N3,600,000 per machine, 70 percent of these costs are for materials and are incurred shortly after the order has been accepted. The remaining 30 percent is for all other costs, which you can assume are paid shortly before delivery, i.e., in 12 months’ time. The company is not at present operating at full production capacity.

A credit bureau has offered to provide error-free credit information about the new customer if the price is right.

V Plc.’s opportunity cost of capital is 16 percent. Ignore taxation.

Required:

a. Evaluate, from a purely financial point of view, if V Plc. should accept the order from the new customer based on the above information. (12 Marks)

b. Comment on what other factors should be considered before a decision to grant credit is taken. (3 Marks)

Answer

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Tags: Credit control, Customer Order Evaluation, Financial Analysis, Risk Assessment
Level: Level 3

Topic: Working Capital Management

FM – May 2018 – L3 – SB – Q3 – Working Capital Management

Calculate the optimal re-order quantity, compare suppliers, and evaluate limitations in Kehinde's inventory management.

Question

Kehinde is a wholesaler who buys and sells a wide range of products, including electrical component TK. Kehinde sells 24,000 units of TK each year at a unit price of N2,000. Sales of TK normally follow an even pattern throughout the year. To prevent stock-outs, Kehinde keeps a minimum inventory of 1,000 units. Further supplies of TK are ordered whenever the inventory falls to this minimum level, and the time lag between ordering and delivery is small and can be ignored.

At present, Kehinde buys all his supplies of TK from Ajoke Limited and usually purchases them in batches of 5,000 units. His most recent invoice from Ajoke Limited was as follows:

Item	Amount (N’000)
Basic price: 5,000 units of TK at N1,500 per unit	7,500
Delivery charges:
– Transport at N50 per unit	250
– Fixed shipment charge per order	100
Total	7,850

Kehinde also estimates an ordering cost of N50,000 per order, comprising administrative costs and sample checks, which does not vary with the order size.

Kehinde stores TK in a warehouse rented at N500 per square metre per annum, with excess capacity sublet at N400 per square metre annually. Each unit of TK in inventory requires 2 square metres of space. Other holding costs are estimated at N1,000 per unit per annum.

Kehinde has recently learned that another supplier, Ema Limited, offers discounts for large orders. Ema Limited’s pricing structure is as follows:

Order Size	Price per unit (N)
1 – 2,999	1,525
3,000 – 4,999	1,450
5,000 and over	1,425

In other respects (delivery charges and order lead time), Ema Limited’s terms match those of Ajoke Limited.

Required:

a. Calculate the relevant:
i. Cost per order
ii. Holding cost per unit per annum (4 Marks)

b. Irrespective of your answers in (a) above and assuming a cost per order of N150,000 and holding cost per unit per annum of N1,800, calculate the optimal re-order quantity for TK and the associated annual profit Kehinde can expect from the purchase and sale, assuming that he continues to buy from Ajoke Limited. (6 Marks)

c. Prepare calculations to determine if Kehinde should buy TK from Ema Limited instead of Ajoke Limited, and in what batch size. (7 Marks)

d. Discuss the key limitations of the method of analysis you used. (3 Marks)

Answer

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Tags: Economic Order Quantity, Holding costs, Inventory Management, Order Costs, Supplier Analysis
Level: Level 3

Topic: Working Capital Management
Series: MAY 2018

PM – May 2017 – L2 – SA – Q1 – Working Capital Management

Calculate KPIs for Kardex’s products, perform a PEST analysis, and comment on KPI effectiveness in external conditions.

Question

Kardex Industries Nigeria Limited is a subsidiary of a large manufacturing company based in China (Kardex International). The company manufactures washing machines, table gas cookers, and refrigerators which are being sold by the subsidiary in Nigeria. Demand for the company’s product is growing, especially among the growing middle-class population, until recently when the company started experiencing some hiccups due to the economic recession and stiff competition.
- The company currently sells two types of washing machines in Nigeria:
  - Wash Up: A basic product comparable to local competitors.
  - Perfect Wash: A premium product similar to Kardex’s offerings in developed countries.
- The competitive environment in Nigeria is evolving quickly. Apart from Kardex, two other companies offer similar machines in the market. One competitor produces machines similar to “Wash Up” locally with tax incentives, while the other is planning to set up a plant for specialized washing machines akin to Kardex’s “Perfect Wash.”
- Kardex International’s mission is to be the “industry leader.” The Kardex Board has identified critical success factors (CSFs) for the Nigerian subsidiary:
  - Market leadership.
  - Profit maximization and shareholder wealth within acceptable risk.
  - Brand image maintenance as a top-of-the-range product.
- The Board suggests using the following KPIs for each product:
  - Total profit, average sales price per unit, contribution per unit, market share, margin of safety, return on capital employed (ROCE), and total quality costs.

Appendix 1
Financial Year Data for Nigerian Subsidiary:

Requirements:

a. Calculate the Key Performance Indicators (KPIs) for Kardex, including:

Total Profit
Average Sales Price per Unit
Contribution per Unit
Market Share
Margin of Safety
Return on Capital Employed (ROCE)
Quality Costs (20 Marks)

b. Use a PEST Analysis to identify external environmental issues affecting Kardex and discuss the effectiveness of the KPIs in addressing these issues.

Answer

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Tags: KPI, Margin of Safety, Market Share, Profitability analysis, Quality Costs, ROCE
Level: Level 2

Topic: Working Capital Management
Series: MAY 2017

PM – May 2023 – L2 – SA – Q1 – Working Capital Management

Calculate Vestapricy Ltd's cost of goods sold, analyze the working capital cycle, and apply decision rules for inventory management in Owerri.

Question

Vestapricy and Company Limited is a manufacturing outfit located in Port Harcourt. It produces a tracking device that is attached to motor vehicles. The device is designed to help locate the whereabouts of stolen motor vehicles within the country. The company’s capital (or cash operating cycle) is the length of time between the payment for purchased materials and the receipt of payment from selling the goods made with the materials.

The table below gives information extracted from the annual accounts of Vestapricy and Company Limited for the past three years.

Extracts from Vestapricy and Company Limited annual accounts for 31st December 2020 to December 2022:

	2020	2021	2022
Inventory:
Raw materials	108,000	145,800	180,000
Work in progress	75,600	97,200	93,360
Finished goods	86,400	129,600	142,875
Purchases	518,400	702,000	720,000
Sales	864,000	1,080,000	1,188,000
Trade receivables	172,800	259,200	297,000
Trade payables	86,400	105,300	126,000

Other information is as follows:

All purchases and sales are on credit.
Direct wages:
- 2021: ₦300,000
- 2022: ₦250,000
Production expenses:
- 2021: ₦72,600
- 2022: ₦171,995
The company’s policy is that any data that will be used from the statement of financial position in determining the working capital cycle period will be average based.

Required:

a.
i. Compute the cost of goods sold for 2021 and 2022. (3 Marks)
ii. Calculate the length of the working capital cycle (assuming 365 days in the year) for 2021 and 2022. (7 Marks)
iii. List the actions that the management of the company might take to reduce the length of the working capital cycle. (5 Marks)

b. In 2023, the company (Vestapricy) decided to open a new small apple shop in Owerri to be managed by a shopkeeper. The shopkeeper is deciding on the number of boxes of special apples it hopes to buy each day. A box of apples earns a contribution of ₦400 and costs ₦250.

Demand for apples is uncertain and could vary from 30 boxes to 10 boxes. Any apple that is purchased but not sold will be thrown away at the end of the day.

The shopkeeper has decided that he will buy 10 boxes, 20 boxes or 30 boxes each day, and these are the only three options he wants to consider.

Required:

i. Construct the Pay-off table for this business in Owerri. (7 Marks)
ii. How many boxes should the storekeeper purchase if the decision is based on:

The Maximax decision rule.
The Maximum decision rule.
The Minimax regret decision rule.
Give reasons for your decisions. (8 Marks)

Answer

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Tags: Decision Rules, Maximax, Minimax, Pay-off Table, Working Capital, Working Capital Cycle
Level: Level 2

Topic: Working Capital Management
Series: MAY 2023

PM – Nov 2018 – L2 – Q3 – Working Capital Management

Prepare cash forecast, profitability, and liquidity ratio for Omegboeji Nigeria Ltd from 2015-2017.

Question

Omegboeji Nigeria Limited is a trading company that specialises in buying and selling of bulk oil. The company is financed by a capital base of N24 million inclusive of reserves in a mix of 30% and 70% of debt and equity respectively. The company has been in the trading business for the past six years and has consistently adhered to its corporate policy on sales, purchases, and inventory management.

The company’s policy on sales is to ensure that sales proceeds are collected as follows:
(i) Cash Sales is 30% of the monthly sales.
(ii) The balance of the month’s sales is to be collected in the month following sales.

The policy on monthly purchases, which is in agreement with the supplier’s policy, is to pay for all supplies in the month following the month of purchase. The general policy of the company is that purchase cost for bulk oil represents 60% of the corresponding annual sales value while its inventory policy is to reserve 30% of the month’s purchases as closing inventory.

The following information is available for the five years 2013 to 2017:

Year	Monthly Sales (N’000)	Monthly Salaries (N’000)	Monthly Rent (N’000)	Monthly Expenses (N’000)
2013	12,000	800	400	350
2014	15,000	800	400	370
2015	16,800	960	400	390
2016	18,000	960	400	390
2017	24,000	1,080	400	380

Additional information:
(i) The company will purchase a motor vehicle in July 2016, which will be paid for in two instalments as follows:

First payment: 60% of cost in September 2016
Balance: To be paid in November 2016
The cost of the motor vehicle is expected to be N7,500,000.

(ii)Annual depreciation for the motor vehicle will be 20% on a straight-line basis. Monthly expenses include annual depreciation for the motor vehicle.

(iii) The cash balance as of December 31, 2014, was N2,500,000.

(iv) The company’s salaries, rent, and expenses will be paid in the month during which they are due.

Required:
a. Prepare a cash forecast for 2015, 2016, and 2017, showing the closing cash balance at each year-end. (10 Marks)

b. Prepare a forecast profitability statement for 2015, 2016, and 2017. (7 Marks)

c. Determine and comment on the forecast liquidity ratio (current ratio) for 2017. (3 Marks)

Answer

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Tags: Cash Forecast, Financial Analysis, Liquidity Ratio, Profitability
Level: Level 2

Topic: Working Capital Management
Series: NOV 2018

FM – May 2021 – L2 – Q3d – Working Capital Management

Discuss one merit and one demerit of engaging the services of a debt factoring agency.

Question

Discuss ONE (1) merit and ONE (1) demerit of engaging the services of a debt factoring agency. (3 marks)

Answer

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Tags: Debt Collection, Factoring Agency, Financial risk, Receivables Financing
Level: Level 2

Topic: Working Capital Management
Series: MAY 2021

FM – May 2021 – L2 – Q3c – Factoring Agency

Define what a factoring agency is and explain its role.

Question

What is a factoring agency?

Answer

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Tags: Accounts Receivable, Factoring Agency, Short-term Finance
Level: Level 2

Topic: Working Capital Management
Series: MAY 2021

FM – DEC 2023 – L2 – Q3 – Discounted cash flow | Sources of finance: debt | Working Capital Management

Identification of cash flow patterns, present value calculation for two payment strategies, and explanation of the benefits and factors related to credit rating.

Question

a) TekApps is a small technology company that develops financial technology (FinTech) applications for mobile devices. The company is selling one of its highly rated FinTech apps to a financial institution. The financial institution has proposed the following strategic payment options for TekApps’ consideration:

Strategy 1: An immediate payment of GH¢1.2 million followed by payments of GH¢50,000 at the end of each quarter during the next five years.

Strategy 2: Payment of GH¢55,000 at the beginning of each month for the next five years.

TekApps’ required rate of return is 25% per annum.

Required:
i) Identify the type of cash flow pattern described under each option. (3 marks)
ii) Compute the present value of the cash flows for each strategy and advise TekApps on the best payment option. (7 marks)

b) BKB Entertainment Ltd (BKB) currently borrows at an average rate of 24% per annum. The Treasury Manager of the company believes that BKB can borrow at a lower interest rate if its creditworthiness is assessed and rated by a rating agency. He has therefore recommended to the Board of Directors to consider requesting a credit rating.

Required:
i) Explain TWO (2) benefits of credit rating to BKB. (4 marks)
ii) Advise the directors on THREE (3) factors rating agencies will consider in determining the company’s credit rating. (6 marks)

Answer

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Tags: Annuity, Cash Flow Patterns, Financial Decision-Making, Payment Options, Present Value
Level: Level 2

Topic: Discounted cash flow, Sources of finance: debt, Working Capital Management
Series: DEC 2022

FM – May 2020 – L2 – Q5b – Working Capital Management

Evaluate the impact of introducing credit sales on total profit before tax for a company and provide management advice.

Question

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on a cash-only basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

Cost of sales: 55% of sales
Staff cost: 10% of sales
Marketing and distribution cost: 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit, and a new credit department is set up to assess and monitor these credit sales. The monthly cost of running this credit department is GH¢20,000, and bad debts are expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:

i) Calculate the total profit before tax before the introduction of the new policy.
(4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy.
(6 marks)

iii) Advise management whether the initiative should be undertaken.
(3 marks)

Answer

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Tags: Credit Policy, Profitability analysis, Receivables Management, Working Capital Management
Level: Level 2

Topic: Working Capital Management
Series: MAY 2020

FM – MAY 2017 – L1 – Q4 – Management of receivables and payables | Working Capital Management

Differentiate between factoring and invoice discounting and advise ATA Ghana Ltd on whether to take on new customers based on the proposed credit policy.

Question

a) Factoring and Invoice Discounting are both financial services that can release the funds tied up in your unpaid invoices, involving a provider who agrees to advance money against outstanding debtor balances. However, factoring is not the same as invoice discounting.

Required:
Differentiate between factoring and invoice discounting.
(5 marks)

b) ATA Ghana Ltd is a company in Ghana engaged in the trading of commodities. The annual sales are GH¢24 million. The average age of debtors is one month, and the percentage of bad debts is 1%.

A new Marketing Director has been hired by the company to improve its sales. The new Marketing Director proposed that sales could be increased up to GH¢30 million if new customers were taken on. Taking on new customers will lengthen the average credit period to 2 months and increase bad debts to 1.5% of sales.

The Finance Manager provided that the variable cost is 70% of the selling price and the company’s cost of capital is 20%.

Required:
Advise whether the company should take on the new customers.
(10 marks)

Answer

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Tags: Credit Policy, Factoring, Invoice Discounting, Working Capital
Level: Level 2

Topic: Management of receivables and payables, Working Capital Management
Series: MAY 2017

FM – MAY 2016 – L2 – Q2 – Working Capital Management

Assessing XYZ Ltd's overtrading status and evaluating proposals to improve cash flow management.

Question

XYZ Ltd is a leading producer of mineral water in Ghana. The company sells all of its output to wholesalers on credit terms net 40. The company’s collection policy is somewhat relaxed, and so the receivables turnover days are currently 53 days. This fairly liberal credit policy has resulted in significant increases in sales revenue in recent years. However, the company has been facing cash flow problems as a significant number of customers take longer than the credit period to settle their accounts. The company typically falls on overdraft facilities from its bankers when it fails to generate adequate cash flows from operations to meet working capital requirements. The average cost of the overdraft facilities is 15% per annum.

Last week, the management team met and discussed the company’s cash flow and liquidity problems with a view to finding solutions to the problems. In that meeting, two proposals were offered to help solve the problems:

Proposal 1: Introduce an early settlement discount of 1.5% on accounts that are settled within 10 days of invoice while the current credit period is maintained. It is estimated that 60% of accounts will be paid within the discount period.

Proposal 2: Switch from financing working capital requirements using the bank overdraft facilities at 15% interest to financing working capital requirements using suppliers’ trade credit. Suppliers are willing to supply on credit terms 1/10, net 40.

Set out below are the company’s income statement and statement of financial position for the past three years.

Income statement for the year ended 31st December

	2012	2013	2014
Revenue	40,000	60,000	122,000
Cost of sales	(15,000)	(31,000)	(90,000)
Gross profit	25,000	29,000	32,000
Selling and administrative expenses	(11,000)	(13,000)	(17,500)
Operating profit	14,000	16,000	14,500

Statement of financial position as at 31st December

	2012	2013	2014
Noncurrent assets:
Property, plant and equipment	13,400	19,000	22,500
Current assets:
Inventory	8,000	15,500	25,500
Trade receivables	6,900	11,210	24,210
Cash	1,110	–	–
Total current assets	16,010	26,710	49,710
Total assets	29,410	45,710	72,210
Equity:
Stated capital	100	100	100
Income surplus	18,510	28,110	36,810
Shareholders’ equity	18,610	28,210	36,910
Non-current liabilities:
Medium-term loan	3,000	2,500	2,000
Current liabilities:
Trade payables	2,200	3,500	8,600
Dividend payable	5,600	6,400	7,500
Bank overdraft	–	5,100	17,200
Total current liabilities	7,800	15,000	33,300
Total liabilities	10,800	17,500	35,300
Total equity and liabilities	29,410	45,710	72,210

Required:
a) Considering the background information and financial data provided above, would you conclude that XYZ Ltd is experiencing overtrading? Explain with relevant computations. (9 marks)

b) Appraise the proposal for early settlement discount (i.e. Proposal 1) and advise on whether it should be accepted for implementation or not. Your appraisal should focus on how the discount policy will influence the company’s profitability. Show all relevant computations. (5 marks)

c) Appraise the proposal to switch from financing working capital needs using bank overdraft to using suppliers’ trade credit, and advise management accordingly. Show all relevant computations. (3 marks)

d) Assuming XYZ Ltd cannot raise additional funds from external sources such as borrowing and new share offers, suggest to management three steps they can take to ease the cash shortages the company is facing. (3 marks)

Answer

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Tags: Early Settlement, Overtrading, Trade Credit
Level: Level 2

Topic: Working Capital Management
Series: MAY 2016

FM – Nov 2023 – L2 – Q5 – Management of receivables and payables | Working Capital Management

Evaluate different credit policies, compute the cost of forgoing a discount, and explain types of financial risks managed by a treasury function.

Question

a) Wahala Ltd wants to employ more liberal credit standards to increase sales. The current annual sales figure is GH¢30 million. Currently, the firm has an average collection period of 30 days. Three alternative credit policies are on the table for evaluation and selection. The management team believes that the alternative credit policies will result in the following:

Factor	Alternative Credit Policy A	Alternative Credit Policy B	Alternative Credit Policy C
Increase in sales from the current level	GH¢2.2 million	GH¢3.1 million	GH¢5.4 million
Average collection period for incremental sales (days)	45	60	150
Bad-debt losses on incremental sales	1.50%	3.50%	8.50%

The prices of its products average GH¢30.50 per unit and variable costs average GH¢21.35 per unit. The company’s pre-tax opportunity cost of funds is 35%.

Required:
i) Evaluate each of the three alternative liberal credit policies and advise the company on which credit policy it should pursue. (Assume a 360-day year). (12 marks)
ii) Suppose the company introduces a discount policy of 2/10 net 45. Compute the cost to a customer who forgoes the discount. (3 marks)

b) The treasury unit of a company performs various functions, including financial risk management.
Required:
Explain TWO (2) types of financial risks the treasury function manages. (5 marks)

Answer

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Tags: Cost of Credit, Credit Policy, Treasury risk management
Level: Level 2

Topic: Management of receivables and payables, Working Capital Management
Series: NOV 2023

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

Question

a) The Treasury Department of LCM Ltd is preparing financial plans for the ensuing financial year. Annual credit sales revenue is projected to be GH¢500 million while the cost of sales is expected to be GH¢260 million. Its current assets are composed of inventory and trade receivables, while its current liabilities comprise trade payables and bank overdraft. The following targets have been set:

Receivables turnover days: 90 days
Payables turnover days: 30 days
Operating cycle: 150 days
Current ratio: 1.1 times

The company’s long-term capital consists only of owners’ equity. The composition and size of long-term capital are expected to remain the same for the ensuing year. The opportunity cost of equity capital is 20%, and the interest rate on the bank overdraft is 18%.

Required:
i) Compute the amount of bank overdraft the company will need in the ensuing year. (6 marks)
ii) Compute the net working capital of the company for the ensuing financial year. (2 marks)
iii) Compute the cost of financing working capital (in GH¢). (3 marks)
iv) Identify the working capital financing policy LCM Ltd is employing. (4 marks)

b) Risk can be hedged through a variety of derivative instruments such as futures, options, and swaps. Each derivative instrument presents its advantages and disadvantages.

Required:
In reference to the above statement, justify why a company would choose a currency futures contract over a currency option contract in hedging currency exposure. (5 marks)

Answer

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Tags: Currency Futures, Currency options, Financing policy, Payables turnover, Receivables turnover, Working Capital
Level: Level 2

Topic: Hedging with options, Working Capital Management
Series: JULY 2023

FM – March 2023 – L2 – Q5a – Management of receivables and payables | Working Capital Management

Evaluate the net benefit or cost associated with the proposed change in Kanzo Food Stores Plc’s credit terms and recommend whether it should be adopted.

Question

Kanzo Food Stores Plc (Kanzo) sells on credit terms of net 60 days. Kanzo’s new Chief Finance Officer (CFO) thinks that the company’s credit terms are too lengthy considering the industry average credit terms of net 45 days.

Kanzo’s annual credit sales revenue is GH¢500 million, and its receivables turnover days are 55 days. The CFO has proposed that the credit terms be revised to net 45 days. Although the tightening of the credit terms would cause annual sales revenue to drop by an estimated GH¢20 million, the CFO believes that the policy change would lower the receivables turnover days to 40 days, which would bring some savings on investment in accounts receivables.

Kanzo has a variable cost ratio of 65% and a cost of capital of 20%.

Required:
i) Compute the net benefit/cost associated with the proposed change in the credit terms and recommend whether the proposed change in the credit terms should be adopted. (10 marks)
ii) The CFO is considering investing funds that would be released from trade receivables in short-term marketable securities. Explain TWO (2) characteristics of marketable securities. (5 marks)

Answer

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Tags: Cost of Capital, Credit terms, Investment in receivables, Receivables Management, Working Capital
Level: Level 2

Topic: Management of receivables and payables, Working Capital Management
Series: MAR 2023

FM – NOV 2016 – L2 – Q2 – Working Capital Management

Discusses the causes of overcapitalization and overtrading, advises on credit policy changes, and explains stock splits and scrip issues.

Question

a) Explain THREE causes each of the following situations:

i) Overcapitalized (3 marks)

ii) Overtrading (3 marks)

b) SAP Petroleum Ltd is considering relaxing its credit policy to boost sales. The change will increase the average collection period from 30 days to 60 days. The review is expected to increase sales by 25%. The current annual sales are GH¢ 6,000,000. Selling price per litre is GH¢ 30, variable cost per litre is GH¢ 27, and additional stock level is GH¢250,000.

Required:

i) Advise on whether to extend the period to customers if all customers take the longer credit of 2 months. (5 marks)

ii) Advise if existing customers do not change their payment terms and only new ones take the longer credit. (4 marks)

c) i) Explain the concepts of stock split and scrip issue and identify the main difference between the two. (3 marks)

ii) Explain why a company will embark on a scrip issue. (2 marks)

Answer

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Tags: Credit Policy, Overcapitalization, Overtrading, Scrip Issue, Stock Split
Level: Level 2

Topic: Working Capital Management
Series: NOV 2016

FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

Question

a) Adjei Departmental Stores’ demand for cash has been quite volatile recently, with the standard deviation in daily cash demand rising to GH¢60,000. The managers of the company are therefore considering using the Miller-Orr model to manage its cash flows. The minimum cash balance would be set to GH¢300,000. The annual interest rate is expected to be 18.25% while the cost of trading investments in securities is GH¢10,000 per transaction.

Required:
i) Compute the cash return point. (4 marks)
ii) Compute the upper cash limit. (2 marks)
iii) Explain how the minimum cash limit, upper cash limit, and cash return point would be used to manage the cash balances of Adjei Departmental Stores. (3 marks)

b) The Founder of a growing technology company has questioned her Chief Finance Officer about the company’s holdings of cash in demand deposit accounts and on hand when the money could be invested in financial securities for returns.

Required:
Explain to the Founder THREE (3) motives for holding cash. (6 marks)

c) Serwaa Home Décor Ltd, a trading company based in Ghana, usually buys foreign currency to settle invoices for imports. The Treasury Manager is considering ways of hedging the company’s foreign currency risk exposures. After considering various options available to her, she has settled on both forwards and futures contracts.

Required:
Explain TWO (2) advantages of currency forwards over currency futures contract. (5 marks)

Answer

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Tags: Cash Flow Management, Currency Forwards and Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management, Foreign exchange risk and currency risk management, Working Capital Management
Series: AUG 2022

FM – Nov 2019 – L2 – Q5 – Inventory Management | Working Capital Management

Explain the impact of different working capital policies on profitability and liquidity, calculate profit under different credit policies, and explain reasons and costs associated with holding stock.

Question

a) In driving the profitability and liquidity position of an organization in the current local and global business environment, one area that has become the center of focus or attention to Management is how working capital is managed. Aggressive, moderate, and conservative policies to working capital management have implications on the profitability and liquidity positions of the organization.

Required:
In the light of the above, explain and demonstrate the impact of each of the policies below on profitability and liquidity:
i) Aggressive Working Capital Management (2 marks)
ii) Moderate Working Capital Management (2 marks)
iii) Conservative Working Capital Management (2 marks)

b) Taaba Oil Ghana Ltd is an Oil Marketing Company operating in the downstream sector of the Oil and Gas industry in Ghana. The company initially was offering 4 weeks credit to its retailers until it changed its strategy to reduce the credit period from 4 weeks to 2 weeks to manage down its financing cost and bad debt.

Under the 4 weeks credit regime, annual credit sales were 500 million liters. The profit made per liter before financing charges and bad debt was GH¢0.20. The total working capital was GH¢250 million, but 50% was funded through trade credit and the remaining 50% was through Bank Overdraft at an interest rate of 25% per annum. The cost of trade credit was already factored into the margin. Bad debt was GH¢0.01 per liter of the credit sales.

The change in policy from 4 weeks to 2 weeks was done immediately without prior advance discussion and notice period granted to retailers who were also selling on credit to their customers.

After operating the new credit policy, the volume of sales was negatively impacted as sales volume per annum dropped by 25% and bad debts increased by 100% due to pressure on the working capital of the retailers. As the new Finance Manager for Taaba Oil Ghana Ltd, you are tasked to review this policy.

Required:
i) Calculate the profit under the old policy. (4 marks)
ii) Calculate the profit under the new policy. (4 marks)
iii) Based on your calculations above, advise management whether to revert to the old policy or maintain the new policy. (1 mark)

c) Holding stock and sometimes over-stocking come at a great cost to a company. Notwithstanding these costs, it is sometimes necessary to hold stock or even overstock for the smooth running of the company.

Required:
i) Explain TWO (2) reasons for holding stock. (2 marks)
ii) State and explain THREE (3) costs associated with holding stocks. (3 marks)

Answer

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Tags: Credit Policy, Inventory Costs, Liquidity, Profitability, Working Capital
Level: Level 2

Topic: Inventory Management, Working Capital Management
Series: NOV 2019

FM – Nov 2017 – L2 – Q4a – Working Capital Management

Explain the concept of overtrading, its symptoms, and how firms can overcome this situation.

Question

Before the credit crunch, tenanted-pub firms borrowed cheaply in order to buy up back street boozers. But the debt crisis and the resulting slowdown have left the tenanted-pub industry nursing the hangover from hell.” – Financial Times, November 27/28, 2010.

Required:
Explain the term “overtrading” and in your answer show how the financial backers could diagnose (or misdiagnose) the main symptoms of this condition, the various possible causes of such symptoms, and how firms could overcome this situation. (8 marks)

Answer

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Tags: Financial Distress, Liquidity management, Overtrading
Level: Level 2

Topic: Working Capital Management
Series: NOV 2017

FM – MAR 2024 – L2 – Q5 – Working Capital Management

Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.

Question

a) Edziban Foods Ltd has just signed a contract to sell food items worth GH¢120,000 per month to the School Feeding Secretariat on credit. With the average collection period expected to be 45 days, the company will increase its working capital requirement by GH¢177,534. The company’s managers are considering three options for financing the additional working capital requirement:

Option 1 – Trade credit: The company buys about GH¢72,000 of food items per month on terms of “2.5/20, net 60.” Going forward, the company may choose to forgo the discount.
Option 2 – Factoring: The company enters a non-recourse factoring contract, under which the factor takes up the receivables to be created from the credit sales under the contract (i.e., GH¢120,000 per month) for a fee of 2% of the credit sales. The average collection period for the credit sales will remain at 45 days. The factor will advance up to 80% of the face value of the average receivables at an annual interest rate of 16%. It has been estimated that the factor’s services will save the company GH¢1,500 per month in debt collection costs.
Option 3 – Bank loan: The company takes a loan of GH¢197,260 at 15% from its bankers. A 10% compensating balance will be required.

Required:

i) Recommend the best financing option to the managers of the company based on annualized percentage cost.
(11 marks)

ii) Distinguish between “without recourse” factoring agreement and “with recourse” factoring agreement.
(4 marks)

b) Explain THREE (3) differences between a forward currency contract and a futures currency contract.
(5 marks)

Answer

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Tags: Bank Loan, Factoring, Forward Contracts, Futures Contracts, Trade Credit, Working Capital
Level: Level 2

Topic: Working Capital Management
Series: MAR 2024

FM – MAY 2018 – L2 – Q4 – Working Capital Management

Evaluates the impact of extending credit terms on a company’s sales, bad debts, and working capital financing costs.

Question

Adjaye Ltd has current sales of GH¢1.5 million per year. Cost of sales is 75% of sales and bad debts are 1% of sales. Cost of sales comprises 80% variable costs and 20% fixed costs, while the company’s required rate of return is 12%. Adjaye Ltd currently allows customers 30 days credit, but is considering increasing this to 60 days credit in order to increase sales.

It has been estimated that this change in policy will increase sales by 15% and bad debts will increase from 1% to 4%. It is not expected that the policy change will result in an increase in fixed costs, and creditors and stock will be unchanged.

Required:

Advise whether Adjaye Ltd should introduce the proposed policy. Support your answer with relevant computations.

Answer

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Tags: Accounts Receivable, Bad Debts, Credit Policy, Financing Costs, Working Capital
Level: Level 2